Economic Turbulence: Is a Volatile Economy Good for America?

Book Review

By Clair Brown, John Haltiwanger and Julia Lane
University of Chicago Press
212 pages

G.M. Will Reduce Hourly Workers in U.S. by 25,000
June 8, 2005

AOL to Cut 5,000 Jobs in Web Access Business
Aug. 4, 2006

Intel to Cut Work Force by 10,500
Sept. 6, 2006

Pfizer, Hurt by Rival Generic Drugs, Will Lay Off 7,800
Jan. 23, 2007

Sounds pretty bad. And it gets worse. Those New York Times headlines reveal just the tip of an iceberg. According to data from the Bureau of Labor Statistics (BLS), almost 115 million workers were separated from their jobs, 40 million of them involuntarily, from January 2005 through January 2007.

You knew the economy was in bad shape, but did you know it was that bad?

Oh, yeah. One more thing. About 121 million workers were hired over this same period, and national employment increased by 5.7 million.

That's right—40 million workers suffered an involuntary separation from their jobs in the midst of a national employment expansion.

What was going on during this period? As it turns out, nothing especially unusual, except perhaps for the above-average employment growth.

That's the lesson learned from two decades of careful research on the movement of workers and jobs over time. Whether the economy is in recession, booming or somewhere in between, changes in national employment mask a huge amount of underlying churn in workers and jobs.

In their book Economic Turbulence: Is a Volatile Economy Good for America?, economists Clair Brown, John Haltiwanger and Julia Lane use the following analogy: Reporting changes in national employment is "a little like reporting changes in the level of a lake, without information about the rivers that flow into and out of the lake" (p. 11). We will see that these flows are indeed rivers and not tiny streams.

While Economic Turbulence clocks in at a mere 212 pages, the reader should be warned that this is not a quick read. The book is filled with careful data analysis, four appendices and 14 pages of reference notes. But don't go away; I'll give you the bottom line in a bit. First, though, let's look at some of the truly striking facts on job and worker flows.

What happened to the jobs ...

The common theme in all the following facts is the remarkable amount of labor market churn that occurs every day in the U.S. economy.

In the United States, over the past decade or so, private-sector job creation and job destruction rates each have averaged almost 8 percent of employment per quarter.1 That is, one in 13 jobs is destroyed every quarter. A roughly equal, though slightly higher, number of jobs are created on average, resulting in relatively moderate increases in the overall number of jobs.

Furthermore, this substantial job creation and destruction occurs simultaneously, regardless of the condition of the economy. For example, a recent study found that during the recessionary third quarter of 2001, 31 percent of establishments contracted (job destruction), but 26 percent of establishments expanded (job creation).

More than two-thirds of all job destruction occurs in sizable blocks, that is, at establishments whose employment shrinks by more than 10 percent in a quarter. This tendency toward large chunks of job destruction helps explain the headlines at the start. However, almost two-thirds of all job creation occurs at establishments expanding by 10 percent or more. A point made by Brown, Haltiwanger and Lane is that the chunks of job destruction often claim a disproportionate share of the employment news, despite the fact that job creation more than offsets the job losses.

... and the workers

The findings on worker flows are even more dramatic. Among workers with job tenure of at least three months, almost one in nine separates from his or her employer each quarter. These include voluntary separations—perhaps for a new job or retirement—as well as involuntary ones. Offsetting those separations are the one in eight workers who are newly hired during the quarter. Paradoxically, 16
percent of those new hires occur at firms that are contracting their employment (destroying jobs!).

Here's one final striking illustration. On the first Friday of each month, the BLS reports on the change in national employment during the preceding month. From 1996 through 2003, the average monthly increase in employment was about 140,000, or 0.14 million. Here are the worker flows that lie behind that number: 4.4 million workers left their jobs (1.4 million became officially unemployed, and 3 million left the labor force), 4.6 million people gained employment
(1.8 million had been unemployed, and 2.8 million had been out of the labor force) and 2.8 million workers switched employers. Each month, then, roughly 11.8 million people took a job, left a job or switched jobs, but all this churn changed national employment by only 0.14 million.

In case you've gotten lost in all the numbers, here's the bottom line: The relatively small changes in national employment mask a huge, continual reshuffling of workers and jobs.

Can volatility be good?

What effect does all this churn have on individual workers and businesses? That is the question pursued in Economic Turbulence.

First, a quick objection to the title. One aim of the book is to document the positive, as well as the negative, effects that turbulence has on workers and the economy, and to dispel some common misconceptions. But at heart, the book is not really about whether volatility is "good" for America. That question immediately leads to a series of other questions: Which volatility? Good compared to what? Could the economy function as well with less volatility? The book only indirectly addresses these issues.

But title aside, this book and the research behind it offer important insights into the role of turbulence in the U.S. economy. The large churn of workers and jobs is intimately connected to the process of allocating resources efficiently in an economy. Within an industry, more-productive businesses tend to expand while less-productive businesses shrink or fail. On top of that, industry composition changes steadily—new technologies and innovations emerge; some
businesses become obsolete. And finally, workers are steadily reallocated from less-productive to more-productive businesses where their talents are most valued (and their wages are higher). Unfortunately, this process has a great deal of uncertainty and experimentation associated with it: Which businesses will succeed? What innovations will come along? Which job is a good match for each worker?

Considerable research has been done on the effects of specific policies intended to reduce various types of volatility—for example, unemployment insurance and employment protections. The standard finding is that trade-offs exist: Reducing volatility comes with a cost. Unemployment insurance provides income support, but decreases the incentive to find work. Employment protections make it difficult to fire workers, which in turn reduces hiring and inhibits efficient
reallocation of workers and lowers productivity.

Tracking individual workers and businesses

The main contribution of Economic Turbulence is that it attempts to connect the broad facts about worker and job flows discussed earlier with the individual experiences of workers and businesses. Brown, Haltiwanger and Lane define economic turbulence as "the entire process of economic change: worker reallocation as workers change jobs and job reallocation from firms contracting and shutting down, to firms expanding and starting up" (p. 3). They cite globalization, technological change, deregulation and the natural selection process as sources of this turbulence. How, they ask, does this turbulence
affect individual workers and businesses?

The book focuses on five industries that vary greatly in their technological level and their use of skilled and unskilled workers: semiconductor manufacturing, software development, financial services, retail food and trucking. The analysis makes use of data—lots of data—from a new program at the U.S. Census Bureau. The data include 854,593,228 observations on 57,823,057 individuals and 2,913,197 businesses, covering the years 1992 to 2003. Like I said, lots of data.

The authors use these data to study the impact of economic turbulence on the performance and survival of firms and on the job ladders, career paths and job quality of workers. This data analysis is complemented by case-study discussions of economic forces (for example, deregulation, technological change) and results specific to each industry. While much of the detailed analysis may be of interest primarily to economists and industry insiders, the overall
conclusions provide valuable insights for a wider audience.

Highlights

Here are a few of the main findings. The analysis of firms uncovers large disparities in the productivity of establishments, even within the same industry. The most productive establishments are more than twice as productive as the least, and they are much less likely to shut down. The authors also document the large amount of business entry and exit; during a 5-year period almost four out of 10 establishments exit, while one out of three establishments is new.

Brown, Haltiwanger and Lane find that firm restructuring is productivity-enhancing. For example, they report that "failing businesses have created a surge in productivity for the retail trade industry ... precisely because low-productivity firms ... have shut down and been replaced by new high-productivity firms" (p. 39).

At the worker level, the book highlights the impact of economic turbulence on workers' career paths and the quality of available jobs. Here the authors provide a detailed analysis of the job ladders (initial earnings and earnings growth) available in various industries, and they report on the career paths of workers who switch jobs, and those who do not, during the 10-year period of study.

Three of the authors' conclusions are:

The proportion of low-income jobs fell notably in all industries during the period, while the proportion of high-income jobs increased substantially.

"Although turbulence imposes short-run costs, in the long-run job change leads to improved jobs for most workers. The evidence does not support the popular notion that 'low-wage workers churn from bad job to bad job' —not even in retail food, where many workers leave the industry for better jobs" (p. 122).

The authors do find that some workers never experience long-term labor market success. Not surprisingly, this is most prevalent among workers with relatively little education. It is unclear what role labor market volatility plays in this outcome.

Missing links

One objective of Economic Turbulence is to remind the reader that job creation and rising productivity are the flip sides of the job destruction story often emphasized in newspaper headlines. On that score the book makes a valuable contribution.

But studying the complex interactions of millions of workers and businesses over time, and explaining the results in a meaningful and understandable way, is a very difficult task. The authors themselves acknowledge this in several places. While the many, specific results are generally digestible, they generate a new list of questions left unanswered.

For example, the authors report that "workers generally find the best job ladders in growing large low-turnover businesses. Small growing high-turnover companies also provide good job ladders, except in retail food" (p. 123). But what do these facts tell us? Can we really conclude from such evidence that, as Brown, Haltiwanger and Lane write, "the best place to go for a worker in the trucking industry is, surprisingly, a shrinking company" (p. 77)? Perhaps something like this proved true during the 1992-2003 period, but how do we know
that it is still true?

Women's job ladders are reported to be much worse than men's; women earn one-third of what men earn in some industry-worker categories. That number is surprisingly low, but the authors make little effort to explain why.

What's fundamentally lacking in Economic Turbulence is a clear theory that allows us to understand and interpret the myriad results. Why do women earn so much less? Why do low-educated people work in retail food when they can earn twice as much in other industries? Why are the best job ladders in large, growing firms?

Furthermore, the absence of an organizing theory also prevents the authors from providing concrete policy advice. The five "policy lessons" the authors deliver in the final pages are unsatisfying. "Most workers eventually find successful career paths—but some do not" seems not a very useful lesson for policymakers.

Still, the careful documentation of a broad set of facts described in this book will surely spur further research. And a better understanding of the tremendous flows of workers and jobs may well lead to important policy insights.

Conclusion

Economists, industry insiders and various analytical groupies of the five industries studied are likely the primary audience for this detailed and thought-provoking analysis of economic turbulence. But the basic lesson should be clear to all. The next time you see a headline announcing tragic job losses, keep in mind the rest of the story.

1 The statistics reported here are from the book being reviewed and from "The Flow Approach to Labor Markets: New Data Sources and Micro-Macro Links," by Steven J. Davis, R. Jason Faberman and John Haltiwanger, Journal of Economic Perspectives 20, Summer 2006.